Cricut, Inc. Q2 FY2022 Earnings Call

Good day, and thank you for joining us. Welcome to the Cricut Second Quarter 2022 Earnings Conference Call. All participants are currently in listen-only mode. Following the presentations, we will have a question-and-answer session. Now, I would like to turn the call over to Stacie Clements, Investor Relations at The Blueshirt Group. Please proceed.

Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricut's second quarter 2022 earnings. Please note that today's call is being webcast on the Investor Relations section of the company's website. A replay of the webcast will also be available following today's call. For your reference, accompanying slides used on today's call, along with a supplemental data sheet, have been posted to the Investor Relations section of the company's website, investor.cricut.com. Joining me on the call today are Ashish Arora, Chief Executive Officer, and Kimball Shill, Chief Financial Officer. Before we begin, we would like to remind everyone that our prepared remarks contain forward-looking statements, and management may make additional forward-looking statements, including statements regarding our strategy, business expenses, and results of operations in response to your questions. These statements do not guarantee future performance, and undue reliance should not be placed upon them. These statements are based on current expectations of the company's management and involve inherent risks and uncertainties, including those identified in the Risk Factors section of the most recently filed Form 10-Q. Actual events or results could differ materially. This call also contains time-sensitive information that is accurate only as of this broadcast, August 9, 2022. Cricut assumes no obligation to update any forward-looking projections that may be made in today's release or call. And with that, I will now turn the call over to Ashish.

Thank you, Stacie, and welcome, everyone. Revenue in the second quarter was $183.8 million, below our internal expectations. We have three business segments: our connected machines, accessories and materials, and subscriptions. Let me first discuss subscriptions. Given the significant growth in new users, we have focused deeply on converting users to subscribers as we entered 2022. This is the area where we have made significant progress and have a sound strategy moving forward. We had feared that the number of subscribers could decline sequentially in Q2 due to the drop in connected machine sales this year. However, all our subscriptions-related initiatives resulted in us adding nearly 60,000 subscribers in Q2. We have a strong roadmap and strategy that we are executing on. However, we think it is prudent to stay conservative on our subscriptions outlook in the short term. Our accessories and materials business is being impacted by lower engagement, increased competition, and higher channel inventory. Our engagement initiatives, which I will discuss later, will bear fruit in the medium to long term. We believe that the channel inventory will continue to correct itself in the coming months. We are focusing on improving the value proposition and affordability of our materials and taking steps to communicate more effectively why consumers should choose Cricut. Let's talk about connected machines. We leveraged the opportunity in 2020 and 2021 to significantly grow our user base. In 2022, we face a very different environment where channel inventory is still high, consumers are more cautious, and prioritizing their spending on essential items and on categories they were unable to spend on during Covid. Channel inventory will work itself out in the next few months. We strongly believe that we have millions of new users to acquire and connected machines to sell. We saw evidence of this during Prime Day sales when we promoted Cricut Joy at $99 during the quarter. Our strategy is to be patient and not impact the long-term health of the category by heavily discounting new machines. In the meantime, the steps we are taking to invest in the platform, improve engagement, execute our subscriptions strategy, and become more competitive in materials will help ensure that we fully exploit the opportunity in connected machines in the future. Despite these challenges, we continue to operate a sound business model that positions us well to emerge from this tough environment in a position of strength. We delivered our 14th consecutive quarter of profitability, with a history of generating cash, which allows us to continue to invest through the downturn. We also benefit from significant opportunities to increase monetization from the 7.2 million users already on the platform, a robust subscription revenue stream, and a strong balance sheet. As I look toward the second half of the year and the continued uncertain environment, these pillars of strength are what will sustain our business in the short term and, just as importantly, position us for long-term growth. We have many levers within our control, the primary being that Cricut is a Platform. This distinction separates us from many other companies. Because we are a platform, we are able to interact with our users throughout their entire crafting journey, from initial onboarding to various levels of engagement and monetization. We are able to rapidly innovate, bring new content and features to our entire user base, communicate directly with our users through various touchpoints, and leverage consumer behavior and data to drive further innovation. I am incredibly proud of the team and all they have accomplished over the past several quarters. Operating in this environment has been challenging, but it has sharpened our focus on the initiatives that will be most impactful to Cricut. Last quarter, I outlined four key areas of investment: improve user onboarding and drive engagement; focus on increased monetization through our subscription software service, Cricut Access, and accessories and materials; continued investments in international markets leveraging our low-cost word-of-mouth marketing playbook; and innovating and expanding the platform. We believe this work will position us to exit current macroeconomic conditions significantly stronger with one-to-one user connections, deeper engagement on the platform, and increased user monetization. Let me walk through each of these in more detail. As a top priority, the team has been intently focused on enhancing our user onboarding experience. The quicker a user gets set up and running, the more they create, engage, and share. To help drive this process, we will be piloting learning kits later this year that combine content, Cricut materials, and software experiences that guide the user as they embark on their Cricut journey. We’re also focused on driving user engagement and creating habit-forming experiences using Cricut. While our engagement metric only focuses on when a user sends a cut command to a machine, we think about engagement on the platform in a much broader context. This includes all touchpoints along the way—discovery and inspiration, bookmarks, user connections, and other aspects of inspiration and sharing in the Design Space platform and community. That, in turn, will drive user stickiness and, ultimately, increased monetization through content, subscriptions, and accessories and materials. We are working to make the design process even easier, offering more design tools, and expanding our content library. We believe these efforts will drive higher levels of engagement over time. In Q2, we added several new features in Design Space such as community-driven notifications, project sharing, enhancements to text capabilities, localized inspiration experiences, and other design capabilities to the platform. We are excited about the progress we’ve made so far. Just as important to our business is turning engagement into increased user monetization. We do this primarily through our subscription business and accessories and materials. We’ve made significant improvements to our subscription product, resulting in strong performance. Our subscription business is as robust as it has ever been, including at the height of the pandemic. We had nearly 2.4 million paid Cricut Access subscribers at the end of Q2, an increase of more than 34% compared to Q2 of last year. Also, at the end of Q2, we had more trial subscribers than Q2 of last year, despite slower connected machine sales, as we saw more existing users begin trial subscriptions for the first time. We will continue to invest in this area to improve the experience and bring new and innovative ways to convert trial subscribers to paying subscribers. In addition to increasing our content library, we are adding new premium design tools available only to Cricut Access subscribers. Positive results from our previously launched Monogram Maker and Automatic Background Removal give us confidence in our strategy for Cricut Access. Additionally, we are expanding user touchpoints within Cricut Design Space to improve our merchandising, marketing, and promotional efforts. We have a strong roadmap and are in the early days of executing on that roadmap. Additional monetization opportunities exist within our Accessories and Materials business, where we continue to innovate in ways that uniquely leverage our platform. Recently, we have broadened our successful Smart Materials portfolio to cover new use cases, introduced a new card-making ecosystem, and expanded into new sublimation blanks. The platform compatibility benefit derived from the integration of our Accessories and Materials with our Machines, Design Space software, and digital content resonates very well with our members. Additionally, we are seeing significant competition, especially online, as well as more placement of competitive materials in our retail channels. While our members realize that Cricut materials work seamlessly with our machines and software, they are more price-sensitive than ever before. We are focusing on making our products more affordable for our consumers via cost reductions and promotions. International remains a key priority for us. The key trends that have driven our business since 2014 also hold true internationally. International continues to represent a larger percentage of our overall business, for relatively small initial investment levels. While more established international markets like the U.K. and Australia are experiencing similar headwinds to our North American business, emerging countries are growing quickly, giving us diversity in revenue growth, especially over the long term. As we enter new markets, we employ the same Cricut playbook, focusing on key influential voices, fostering community, partnering with key retailers, and continuing to build out our robust platform to support our worldwide community of users. Investments in international markets continue to deliver success, including significant progress on Design Space localization, as well as new country launches in Thailand and Turkey, with India, Japan, South Korea, and Taiwan coming soon. We’ll continue to build the platform, localize products, and expand awareness by leveraging our proven go-to-market model and network effects. All these investments ultimately expand our platform—whether it’s adding new software features, content, or personalized experiences—all enrich the community experience around the world. For example, our Contributing Artists Program, launched in Q1, expands our platform, drives engagement, and creates opportunities for increased user monetization. All images from Contributing Artists are available for purchase as standalone images within Design Space, and for subscribers, they are included in our Cricut Access subscription service. We are in the early days of this program and are excited by the initial results. We have also been working on a significant enhancement to our software and images architecture. Today, when an image contains text, that text is treated graphically. It is not easy for a user to customize their text, as we don’t retain the font in the initial graphical image. We are developing a new architecture along with a new class of images called editable images. Editable images will allow users to easily modify the text in the image and customize it in a variety of ways. This new class of editable images, along with the software features, will be available later this year to Cricut Access members as part of their subscription. We have a solid roadmap of feature enhancements for editable images. Our focus on the platform has never been higher than it is today. We are improving every aspect of the platform including design tools, community features, engagement-related features, data capabilities, search, mobile-specific initiatives, Cricut Access features, and much more. I could not be more excited about the opportunities ahead. Underscoring our confidence are four key trends that demonstrate resilience in the market and have driven our business forward since 2014: first, the desire for personalization; second, the digitization of tools that makes personalization easy and seamless; third, technology has opened the door to a new generation of entrepreneurs; and fourth, the proliferation of social media drives community—a significant barrier to entry for others looking to enter the market. Although there is still a lot of uncertainty in the current macro-environment, we are as confident as ever about our medium and long-term opportunity for growth. I am very optimistic about the foundation we have laid over the last ten years and excited about how laser-focused the team is on the most important things we need to accomplish in the short and long term—optimizing the trade-off between current profitability and investments in our long-term growth opportunities. Notwithstanding the current environment, our foot is squarely on the accelerator toward sustainable long-term growth. Many of our investments are showing signs of success, building confidence that what we’re doing today will have lasting impacts for long-term growth. I’ll now turn the call over to Kimball for more details on the financials.

Thank you, Ashish, and good afternoon, everyone. Q2 was a challenging quarter for us. We believe the macro trends we have been navigating will likely continue into the back half of the year. However, we are tightly managing what is within our control. In the second quarter, we generated revenue of $183.8 million, a 45% decline compared to prior year Q2, and generated $13.8 million in net income. Breaking revenue down further, revenue from connected machines was $35.4 million, down 76% year-over-year, against significantly difficult comparisons due to the unusually high sell-in we had in Q2 2021. Just to remind everyone, sales of connected machines in Q2 last year were unusually high as retailers replenished inventory and stocked up on newly launched machines. Q2 was impacted by macroeconomic pressures, softer consumer demand beginning in March, and higher-than-normal channel inventory positions that some of our retailers held as we entered the quarter. We anticipate retailers will continue to work down their inventory levels through the end of Q3. As Ashish mentioned, consumers are also prioritizing their spending on essential needs and other categories they missed out on during the pandemic. For context, one way we have evaluated the impact of channel inventory versus consumer behavior is to compare new user additions for the quarter, which were down almost 34% year-over-year. New user additions correlate with machine sell-through. Revenue from subscriptions was $67.6 million, up 33% over last year and 4% sequentially, a remarkable accomplishment given the pressure we saw in connected machines revenue and a demonstration of the durability of our business model. For several quarters now, we have invested in Cricut Access, and the success we saw in Q2 validates our strategy. Revenue from accessories and materials was $80.7 million, down 41% year-over-year, reflecting similar pressure from increased channel inventory levels, macroeconomic trends, and competition. In terms of geographic breakdown, international markets grew as a percentage of total business, representing 13.2% of total revenue, compared to 8.5% in Q2 of the prior year. Revenues from international markets on a year-over-year basis decreased by about 14%, with softness in our most mature markets like the U.K., although somewhat offset by growth in newer geographies. On a two-year basis, international revenues have grown 140% compared to Q2 2020. During the second quarter, we continued to fuel our monetization flywheel for long-term growth. We ended the quarter with nearly 7.2 million total users, which is up 1.8 million users year-over-year. The number of users engaged on our platform for the 90-day period ending June 30 was 3.7 million, up 17% year-over-year. As a percentage of total users, user engagement was 51% in the second quarter, down from 59% in the prior year. There are multiple factors influencing engagement, including seasonality, post-pandemic openings, and macroeconomic factors. Historically, summer is the lowest period for engagement. We believe that when trends normalize and consumers are ready to create, there is no real alternative to the Cricut Platform. In the meantime, we continue to make it easier and faster to engage with us. We also continue to see strong momentum with Cricut Access. The number of paid subscribers grew by more than 600,000 on a year-over-year basis, ending the quarter with nearly 2.4 million paid subscribers. Attach rates continued to be strong, ending the quarter at 33%. As a reminder, this is a significant increase from pre-pandemic periods when our attach rates were in the mid-20s. We measure user monetization through Average Revenue per User (ARPU) in both subscriptions and accessories and materials by dividing revenue for the period in those segments by our entire user base. ARPU for subscriptions in the second quarter was $9.59, down from $9.83 in Q2 2021. Accessories and materials ARPU closely relates to user engagement. ARPU from accessories and materials in the second quarter was $11.45, compared to Q2 2021 ARPU of $26.67, which was higher due to unusually high engagement trends during COVID and also reflects retailers reducing purchases in 2022, as they right-size inventory levels. Moving to gross margin, total gross margin in the second quarter was 46.5%, an improvement of 7.5 percentage points compared to Q2 2021, highlighting the benefit of our diverse revenue streams. Breaking gross margin down further, gross margin from connected machines in the quarter was 1.6%. On a year-over-year basis, connected machine margin is down compared to an unusually high 20.6% in Q2 2021, which benefited from pandemic tailwinds, with elevated machine sales and less promotional activity. Connected machine margin was also impacted by end-of-life machines, which carry lower gross margins. We expect end-of-life machines to affect gross margin through mid-2023, as we sell through remaining inventory. Our strategy is to preserve pricing, being careful not to discount newer machines too much, while working through end-of-life inventory. In addition, Q2 2022 included elevated freight, warehousing, and handling costs. As we move through 2022, we anticipate increased commodities and labor costs. Gross margin from subscriptions increased slightly in the quarter to 90.9%, reflecting leverage in our subscription business. Gross margin from accessories and materials in the second quarter was 29.1%, down from 39.9% in the prior year, primarily driven by higher freight and handling, excess inventory reserves, and higher sales incentives. In Q2, we rolled out price increases with our retail and distribution partners across connected machines, accessories, and materials to help mitigate the impact of the recent cost escalations. We expect to materially benefit from these actions later in the year, once retailer inventory levels are right-sized and they begin placing larger replenishment orders. Total operating expenses in the second quarter were $65.4 million, including $10.3 million in stock-based compensation. This was a decrease from $66.1 million in Q2 2021. For context, we began to slow hiring significantly in late Q3 last year and entered 2022 with a cautious outlook on operating expenses. In Q1, we reprioritized investments to focus primarily on products that will launch in the next 12 to 24 months. These products will expand our existing cutting machine category, as well as create new subscription services and materials. We've prioritized other investments critical to driving medium to long-term growth, including international markets and platform investments, including data, software, and Cricut Access. Some of these investments are already showing promising early results, like the increase in trial subscriptions for Cricut Access despite lower machine sales and the adoption of the Contributing Artists Program. We intend to keep these investment plans in place, given their focused nature and disciplined approach. The fundamentals of our business remain sound, and we believe we have the resources to navigate the current macro environment and invest—without sacrificing long-term operating margins, profitability, or cash flow. Should the macro environment significantly deteriorate, bringing our internal forecasts down, we would look to reprioritize investments, predominantly through variable cost reductions and other trade-offs among the biggest impacts, time horizons, and growth opportunities. Operating income for the second quarter was $20 million, or 10.9% of revenue, compared to $64.2 million, or 19.2% of revenue in Q2 2021, driven by lower revenues in the quarter and increased investments. While navigating headwinds in the short term, we remain focused on managing our resources and continuing to deliver healthy operating margins, even though in the short term they will likely be below the long-term target range of 15% to 19% by a few points. Our business remains durable, with a healthy profitability profile. We delivered our 14th consecutive quarter of positive net income. Net income in the second quarter was $13.8 million, down from $49.1 million in Q2 of the prior year, and up 56% from Q2 2019, pre-pandemic. Diluted earnings per share was $0.06 compared to $0.11 sequentially and $0.22 in Q2 2021. Turning now to the balance sheet and cash flow, our balance sheet is strong and enables us to navigate these challenging macroeconomic times. We ended the quarter with $231.3 million in cash, cash equivalents, and marketable securities, and our new $300 million credit line remains untapped. We continue to generate healthy cash flows. Cash generated from operations year-to-date was $13.0 million. Cash generated is the primary source of funding for our annual inventory needs and additional investments for long-term growth. This fosters a balanced and disciplined approach to capital allocation. As part of this balanced approach, Cricut’s board has authorized the repurchase of up to $50 million of its Class A Common Stock. This program allows us to put cash to good use without sacrificing flexibility to invest in attractive organic and inorganic opportunities. Let me spend a few minutes talking about what we see as we look ahead to the rest of the year. We continue to see soft consumer demand and expect this to persist for most of the year. We anticipate a moderate lift in sales toward the end of Q3, and a more pronounced lift in Q4, as retailers fulfill new orders for the holiday season. As highlighted in our Q4 comments, we noted that the second half of the year typically represents 60% of annual revenue. Given the current macro environment, we expect second-half revenue to be slightly softer than this historical pattern. We remain committed to our annual operating margin targets of 15% to 19% over the long term. We anticipate operating margins in Q4 to begin improving; however, we will likely be below our long-term targets by a few percentage points for the full year. Looking at the long-term, we believe the trends that have driven our business over the last eight years remain intact. We are confident in the unique value proposition that Cricut brings to millions of users and to the millions more around the world that we have an opportunity to bring to the Cricut platform. The significant growth in our user base over the last two years also provides the opportunity to further drive engagement and monetization. We are focused on managing our profitability while investing in areas with the highest impact, including improving onboarding, fostering higher levels of engagement, and innovating on our platform to drive growth in Cricut Access and our accessories and materials business. With that, I’ll now turn the call over to the operator for questions.

Thank you. Our first question comes from Mark Altschwager with Baird. Your line is open.

Hi, thank you for taking my question. So to start out, just the number of engaged users, I think, is up about 20% year-to-date. The number of paid subscribers is up almost 40% on average year-to-date, yet that accessories and materials revenue is down about 27%. So I'm hoping you can help us understand or unpack a bit more. How much of this pressure on accessories revenue is channel destock versus users doing fewer projects or consuming maybe less per project? I think there's maybe a mix and a price component going on in there. So a lot of moving pieces. So I'm just trying to better understand what type of normalization we might see.

Thanks, Mark. So, you know, we’ll give you a broad view of that and just what the factors are, but you outlined some of them. The first thing is, clearly, engagement at the macroeconomic conditions put significant pressure. We think that's a chunk of that, which basically drove ARPU down, and we believe was a significant contributor to that. We talked about the post-pandemic behaviors and the like, but I think it's a combination of those two things. The second is, channel inventory. Since the ARPU number is based on selling, we’re obviously not selling as much as we work through the inventory in the next few months. We think that was a second contributor, but less compared to the engagement one. Last but not least is competition, which is important for us to address. This part of the business has always been the most competitive. For many of our materials, we can differentiate those materials effectively through IP, software, content, etc.; however, some of our portfolio is more prone to competition, specifically in the heat transfer vinyl category. Our approach will be to promote our products more effectively while balancing that with similar cost reductions. We think the contributor has been a combination of factors, specifically engagement being down—not just from a seasonality perspective, but also across the board, given that people are now outside and doing other things. The second factor was channel inventory, and the third factor was competitive pressures.

That's very helpful. Thank you. Kind of switching topics, heading into the back-to-school and holiday season. Talk about your positions in the retail channel relative to last year. I guess, any metrics you're able to share on maybe the number of retail doors you're in today versus last year in the U.S. and internationally? And then I know word of mouth has always been very powerful for Cricut, but maybe talk about your plans to drive awareness with other marketing activities as we enter this more important time for your business.

Yes, one of the things that we've talked about before, right, which is that as things normalize—we’re seeing the impact of seasonality. Even though I know you didn’t ask the question, let me highlight that the drop from Q1 to Q2 is very similar from a seasonality perspective as last year, right? The exaggerated drop to lower levels is more due to post-pandemic opening compared to last year. However, our retail placements continue to be very strong, right? Unlike other categories, we know that when the consumer comes back, there is an alternative platform of choice. One thing that Kimball mentioned is that even though our revenue declined by 76%, our net user adds were only down 34%, which we attribute to consumer sentiment and macroeconomic conditions. We feel good about our awareness, right? We've invested a lot in driving awareness and familiarity. For instance, we promoted Cricut Joy during Prime Day and saw a significant uptick, indicating that there is pent-up demand, and the consumer is willing to engage at the right price. However, we want to be patient. We have around 7 million customers, and there is a huge opportunity to drive engagement and monetize that. Given our view of the trends and our investments in the platform, we feel confident in leveraging our existing installed base and awareness initiatives to drive growth in the medium to long term. From a retail perspective, we have not lost any placement and have maintained most of our retail doors.

Thank you. And just maybe one last quick one for Kimball, just on the balance sheet and inventory. Any obsolescence risk in that number as it remains elevated? And then what should that normalization look like over the next 12 to 18 months? Just what's a normalized level of balance sheet inventory for you as you work through some of that older product?

Yes, so to the first part of your question, we have several machines that are end-of-life. There may be pockets of write-offs related to specific SKUs and geographies, but not generally across the board. As for our inventory strategy going forward, during the pandemic, we intentionally held more finished goods inventory than we normally would, and we have continued that strategy as we have not seen significant changes in lead times. As we move into next year, we are closely monitoring that trend with consumer demand in mind to ensure that we aren't too heavy on finished goods inventory.

Thank you. Our next question comes from the line of Erik Woodring with Morgan Stanley. Your line is open.

Hey, guys, thanks for taking my questions. Maybe Ashish, first one for you. You talked about entering India, Japan, Taiwan, and South Korea in the coming months. Can you just talk about what you've done in those markets to prepare for a launch? The reason I ask that is obviously your biggest competitors are based out of that region, and so I'd imagine competition might be a bit more intense in those markets. How are you getting the brand name out there? How are you getting customers to think of Cricut first and foremost as you prepare to launch? And then I have a follow-up. Thanks.

Yes, Erik, thanks for the question. We've had a presence in Asia for quite some time. Our Head of Asia, although we have a small team, has spent considerable time in those markets specifically. Even though you're correct that some of our competitors are in that region, we don’t see performing competitors particularly in the retail space. Our go-to-market approach is very different from the incumbent competitors. We don’t believe the market has been completely commoditized. Moreover, while there is a competitor in Japan, they mostly operate through dealer channels, leading us to believe there isn’t much retail presence for many competitors today. Our formula is the same we’ve employed in several markets: a small team we put into those countries, working with influencers, engaging with the community, and building the market organically. The investment in each of these countries isn’t massive, but combined, it adds up. We’ve been working on content and influencers, and we feel confident that we can leverage the knowledge we’ve gained to drive demand effectively.

Okay, super. Ashish, thank you for that. That was really helpful. Maybe, and I don't know if I should phrase this to you or Kimball, but last quarter you guys had talked about how the excess channel inventory had fallen to about $28 million at quarter end. I just love to know where it is now, because I thought if I interpreted your comment earlier about net new users being down 34%, that would imply that the incremental 40% of declines in connected machines was due to channel stock. That would imply around $62 million of headwinds. If you could just help me square that circle and where excess channel inventory is today and how it splits between connected machines and accessories and materials, that would be helpful. Thank you.

So, thanks, Erik. This is Kimball. As we talked about, we ended the year with what we thought was about $35 million heavy in channel inventory, based on historical trends that retail was holding as we move through pandemic years. As we went through Q1, we saw some retailers worked through their positions or begin to work through them, while others were actually building their position. What changed in Q2 is that retailers across the board started working through their inventory positions, and we have seen that focus intensify in recent weeks. So, to some extent, we think the goalpost shifted on what retailers are expecting for their optimal inventory levels. However, with everything we know today—watching sell-through trends, looking at consumer demand and conversations with retail partners—and layering in our expectations of the holiday, we expect the channel to reach its target inventory levels towards the end of Q3. This will put us in a position to place larger replenishment orders late in Q3 and more into Q4 to prepare for the holiday.

Let me just add that the 34% user adds correlate quite extensively with what’s happening in the market. The 76% decline is exaggerated because, as I remind you, last year we were launching new machines, and a significant amount of inventory went into the channel. That factor plays a role, too.

Okay, thanks for that. And maybe just one last question from me is, on the pricing side, you talked about rolling out price increases. What has the demand response been? I realize it's a tough market backdrop. However, could you help us better understand your desire to increase prices versus the need to discount due to channel issues, competitive pressures, and demand pressures? Does that equate to net pricing declines when you factor in discounts? Or maybe just clarify the pricing strategy as we think about it today? And that's it from me. Thank you so much.

On the price increases, we implemented those over the course of Q2, and sell-in was softer for the quarter as we've already discussed. We haven't seen the impact from that yet, right? So we do expect to see a benefit from these price increases as sell-in resumes. Moreover, as Ashish mentioned, we will be strategically promotional to ensure we compete well against competitors, especially regarding vinyl and heat transfer vinyl.

I think the data is a little muddied by the fact that we have end-of-life machines we are working through, so the average price may obscure some of that. However, in general, we are not going to leverage the price lever excessively, as we believe it's essential to be patient. A net impact may not reflect this, but it's mostly driven by these end-of-life machines we have. For most of our newer products, we are not being overly promotional.

Yes, thanks for the question, guys. Can you hear me?

Yes.

So I wanted to check, we were just trying to figure out the inventory cash flow here, it looks like you spent about $35.7 million of cash outflow into inventory, but then the inventory level on the balance sheet remained roughly stable, and we see these other assets line moving up. So I wasn't sure how that $35 million, $36 million kind of materialized on the balance sheet. I wonder if you could help us understand that a little better. And then I've got a follow-up.

Yes, we classified some component inventory as non-current inventory that shows up in other assets, which accounts for that $35.1 million. As we went through the pandemic, we were ordering components at a 78-week lead time. Therefore, some of those components won't be fully utilized in the next 12 months and will be classified as non-current.

Oh, I see. So it's a current— because they're current inventory that will be used in the next 12 months, that's why they go into other assets and not into inventory. Is that right?

It's because the components won't be fully consumed within the following 12 months, thus qualifying them as non-current.

Got you. Okay, I got that. And then the other—I wanted to come back to this pricing point and just ask you guys, when I go online and I look at Joys and other products out there, they're all being discounted by the retail channel, which makes sense, right? People are trying to move them out of inventory. But we have—and historically, we've seen that kind of discounting get sticky when it comes to pricing. So the company then struggles to regain its prior pricing levels. I know that you said that your intention is to raise prices and so on. But I just wonder how big of a risk you think pricing is out there, given you have this channel clearance going on, how do you control for that?

Yes, a couple of things, Rod. First, we have a MAP policy that we're diligent about enforcing. There are some issues with machines nearing the end of their lifecycle affecting this aspect, but for our newer machines, we want to maintain price stability. Our experience with connected machines leads us to believe we don't need to release a machine every year or two, allowing us to avoid price degradation. Given the investments we are making in the platform, we will increasingly leverage it to maintain the longevity and stability of pricing in the market. Updates in our value proposition will help improve our positioning.

Great. Okay, thank you very much. Appreciate that.

Thank you. Our next question comes from the line of Jim Suva with Citi. Jim, your line is open.

Hi, my first question is, you mentioned inventory. I think you said exiting Q3 should be more in line. How should we think about that? Or you said more rightsized. As we head into the holidays, exiting Q3, let's call it, at the end of October, isn't that far away from kind of the Black Friday, Thanksgiving, holiday season. So at that point, are you stocked and ready for the holidays? Or is there going to have to be a quick replenishment after that, which seems kind of interesting timing?

So Jim, when we're talking about towards the end of Q3, we're thinking mid to late September is when those replenishment orders normally would be coming in for holiday, around the same time that we see the retailers hitting their target inventory levels. We think the uptick in sales will coincide with normal holiday buying.

Okay, that makes sense. Then the second item I had was an observation from our family. We recently tried some of the Cricut knockoff vinyls and, to be honest, it gummed up our machine. I spent hours cleaning it off, and details and iron arms flaked and came off on the T-shirts from the birthday parties we held. It was a disaster. While you're smiling, the opportunity is how do you educate consumers and customers about that because when you see something at a lower price, you kind of got to try it. I don't blame them for trying it, but I had no knowledge, so I tried it thinking it was going to be okay, but it resulted in a complete gum-up disaster and wasted my time. It seems like knockoff brands are cheaper for a reason—the quality is different. How do you convey that to purchasers?

Yes, Jim, we believe in the significance of this matter. We work across our software and our machines to provide a seamless experience for our consumers. However, we acknowledge that pricing and affordability should be key factors. People are more tempted to try lower-cost options; therefore, we need to better communicate the advantages and peace of mind that come with our products. As part of our strategy, we will work towards making our products more affordable and improve our messaging on the value proposition and differentiators of our materials through Design Space, our platform, and retail channels.

And then my final question is, it seems like the average accessories and items used per user is at an all-time low—even before COVID, it has never been this low. I’m talking about $11.45. So does that mean that the current reported quarter and the next quarter may be kind of the worst you think, and then people start to re-buy and replenish? Do you think that the channel normalizes at some point to levels around $11 to $12?

I think the two factors that I mentioned—engagement and macroeconomic conditions played a significant role in this. However, as channel inventory normalizes, we believe that there is optimism and a positive outlook for that business. I also think that from an engagement perspective, our initiatives are positioned well to engage these customers, which is pivotal since they start contemplating materials several days before activating the project. We are committed to enhancing the user experience and educating customers on materials, and I remain optimistic about improving this in the medium to long term.

Got it. Thank you for that color, guys. I appreciate it.

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